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Oil market contango structure questioned by traders as prices hold

Oil markets have entered into contango after the coronavirus outbreak in China triggered concerns over demand, but traders are already questioning how long the bearish market structure will last.

The front two months of ICE Brent crude futures flipped into contango on February 3 after the expiry of the March contract. The last time the two contracts were in contango was early March 2019. At 1630 GMT Wednesday, the contango between April/May was 12 cents/b, with April at $54.92/b and May at $55.04/b.

“This is a very serious shift in the forward curve, now pricing in substantial concerns about oil demand destruction and consequently steep crude run cuts in China, due to the coronavirus epidemic,” S&P Global Platts Analytics said. “The significant shift in the shape of the Brent forward curve has implications for trade flows, price spreads between WTI/Brent and Brent/Dubai, and producer hedging activity.”

Contango is a structure which shows longer-dated oil futures trading higher than the prompt price, incentivizing traders to store crude in readiness for a more profitable resale at a later date.

But Platts Analytics has cautioned that “we are not completely convinced that the Brent curve will stay in contango for a long period,” highlighting that supply issues such as the 1 million b/d outage in Libya have not been priced in.

OPEC and its allies have seen the Brent oil price fall 20% since the virus fears escalated and sources in the past have admitted that market structure has as much importance as the spot price. The 23-member grouping is mulling deeper cuts in order to offset a substantial decrease in oil demand.

‘Armageddon’
Oil traders have also said it is difficult to call the duration of the new structure, but see the backwardation returning unless there is a long-term systemic cut in demand.

“I doubt it’s a long-term thing, we haven’t seen it in a long time,” one trading source told Platts. “Previously, demand was poor, but that was underpinned by production cuts.”

Meanwhile, Commerzbank said Wednesday that the Brent forward curve “points to an oversupply lasting into the second quarter.” The bank added “the picture of an oversupplied market is also confirmed by the steep 4.2 million barrel rise in US crude oil stocks last week that was reported by the API.”

This uncertainty is pronounced across the oil products spectrum, especially in gasoil markets.

“Front-spread in Singapore is at its highest it has been all year but then paper market pricing in Armageddon. Never seen such a divergence between them,” one trader told Platts.

China’s appetite for crude has been in serious doubt after the virus outbreak, which shut down factories. The world’s biggest importer of crude could see its refiners cut runs sharply in February — up to 2 million b/d according to some estimates — due to economic weakness, with independent small-scale refineries being the hardest hit. In Shandong, home of the small-scale independents, the government has banned trucks registered in other provinces to ship out products, local refiners said.
Source: Platts

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